A curveball for pitch contests

Business plan and pitch competitions have become a way of life in Austin’s technology sector.

But changes to public solicitation rules intended to make it easier for startups to raise capital through crowdfunding could make the old-school pitch events a risky proposition for some companies. In fact, some local investors are already giving pitch-happy startups the cold shoulder.

The U.S. Securities and Exchange Commission changed its rules in September 2013 and now allows startups to publicly raise money online as part of the 2012 federal JOBS — or the Jumpstart Our Business Startups — Act. In other words, anyone can be an investor online — they just won’t get equity in the targeted venture.

But in the real world — outside the realm of Kickstarter, IndieGoGo and other crowdfunding sites — startups are still required to provide the same information to all equity investors. So a startup could be in jeopardy if it discloses varying degrees of information in different settings. That’s often the case on the business plan pitch circuit, which urges entrepreneurs to alter and refine their pitch each time. Just keep in mind that a uniform set of financial information such as revenue projections, details about the management team and marketing strategies need to be available to everyone instead of only selected investors.

On top of that, companies raising money outside crowdfunding sites are also obligated to make sure every investor they work with is accredited. Accredited investors report a net worth exceeding $1 million, not including the value of their primary residence, earning more than $200,000 annually.

So, again, entrepreneurs could find themselves crossing regulators if they attempt to crowdfund from attendees of a business plan competition.

The SEC’s rule changes — and more are expected soon from state and federal regulators — have industry observers worried that the rules send mixed signals. Some think ithe changes could make investors wary of pitch event participants, while others said it will have little effect because pitch competitions are mostly for practice anyway and most investors don’t use them to decide on which startups to back.

“The intention of the rule change was to create more opportunity, to make it easier for companies to get funding,” said TechStars Director Jason Seats. “But absolutely the short-term impact has been to limit some things due to the complexities and uncertainty.”

But business plan competitions have evolved into pitches with startups using presentations typically used for angel groups or venture capital firms. And such investors frequently attend the events looking for prospective portfolio companies.

In addition to the accelerator and incubator pitches, commonly called demo days, South By Southwest Interactive, TechCrunch, the Greater Austin Chamber of Commerce and other organizations often host pitch events. Additionally, the University of Texas hosts such contests organized through groups such as 1 Semester Startup and the Herb Kelleher Center for Entrepreneurship at the McCombs School of Business.

The events are not only about raising money. They give entrepreneurs a chance to refine their pitches and “communicate their value propositions,” said Dreamit Ventures Managing Partner Kerry Rupp.

“Getting that practice is really relevant,” she said.

Pitch events are rarely a source of deal flow for the Houston-based Mercury Fund, a frequent investor in Austin startups, Managing Director Ned Hill said. Instead, he learns about up-and-coming startups from his networks.

Some entrepreneurs are getting around the new SEC requirement by not outlining the amount of capital they’re planning to collect from investors.

“It’s silly that they have to do that,” Hill said. “On the other hand, it’s understood that they’re trying to raise money.”

The lack of clarity has forced the fast-growing Central Texas Angel Network, a group of local high-worth investors, to verify whether potential portfolio companies have followed the regulations. As such, the group tries to verify accreditation verification processes, Chairman Rick Timmins said.

“We’re still cautious,” he said. “Our preference is not to do deals with public solicitation companies.”

Crowdfunding has come into vogue since the success of websites such as Kickstarter and Indiegogo. They’ve enabled startups to appeal to consumers for financial backing instead of traditional venture capital firms, banks or angel investors. It seems like a reasonable approach, but regulators are wary of putting unsophisticated investors at risk.

Many Austin-area companies have benefited from Kickstarter. Such startups have generated more than $20 million in pledges and more than 1,000 local companies have reached their funding goals, Kickstarter spokesman Justin Kazmark said in an interview earlier this year.

But Kickstarter is a rewards-based funding tool. Investors don’t receive any equity or benefit if a company does really well after it has become profitable.

Federal officials plan to expand on the crowdfunding approach and broaden the pool of potential investors as a way to give startups a financial boost. However, the SEC has been slow to formulate all of its crowdfunding regulations, which would affect interstate crowdfunding.

Some individual states are requesting exemptions to the proposed federal rules and establishing their own for intrastate crowdfunding. The Texas State Securities Board is scheduled to finalize its crowdfunding rules Aug. 28.

“The important thing about crowdfunding as it’s gotten a lot of national attention is that it’s not a total solution for anything” Securities Commissioner John Morgan told state legislators in May. “It’s a tool in the tool kit for small companies.”

Crowdfunding rules being considered by the State Securities Board include allowing unaccredited investors to invest $5,000 per year in a company. Also, audited financial statement would only be required of companies raising more than $1 million.

Morgan considers a website portal on which all fundraising would be listed with related communications for 21 days as a “key feature” of the rules proposed for Texas. They would also streamline the reporting requirements for startups.

Nathan Roach, a partner for the San Antonio-based Ram Law Firm PLLC, said he expects an initially negative impact on pitch competitions in response to the new rules before things eventually return to normal.

“At lease in the short term, it will probably reduce the number of people hosting these pitch competitions,” he said. “But in the long run it will be the same as it always has been.”

Colorado-based TechStars, which has mentored several dozen startups since opening an Austin office in 2013, isn’t as optimistic. Seats said the SEC has inadvertently done more harm than good for fledgling startups.

“The intentions are good, but the mechanics are wrong,” he said. “I think it’s an irony for sure.”